Plan Sponsors Can Self-Audit Before an IRS Examination

Sep 28, 2022

Voluntary compliance tools are an important part of the IRS’s retirement plan enforcement strategy. If a plan is out of compliance, the primary IRS goal is for the plan sponsor to make the necessary changes to bring the plan into compliance, although it also has the authority to assess penalties, taxes, interest, and even disqualify a plan. Recently, the IRS announced a new enforcement initiative that involves plan sponsors auditing their own plans.

New 90-Day Pre-Examination Compliance Program
Under its new compliance program, the IRS will send “pre-examination” letters to plan sponsors it has selected for the program. Upon receipt of the letter, a plan sponsor will have 90 days to review the plan document and operations for compliance issues and respond to the IRS.
  • If a mistake eligible to be self-corrected under the IRS’s Employee Plans Compliance Resolution System (EPCRS) is uncovered, the plan sponsor should complete the correction and include a description and supporting documentation in its report to the IRS.
  •  For errors that are not eligible for self-correction, the plan sponsor can propose a correction method and request a closing agreement (which should be less expensive than if the error were found by IRS examiners).
  • After receiving the plan sponsor’s self-audit report, the IRS will determine whether to issue a closing letter without auditing the plan or to schedule a limited or full scope examination. If a plan sponsor does not respond to the IRS within the 90-day window, the IRS will schedule an examination of the plan.
  • This pilot program provides plan sponsors with the opportunity to find and fix compliance errors to prevent an IRS audit or reduce the scope of an audit.
Self-Auditing Your Plan
Even if your plan never receives a pre-examination letter from the IRS, consider periodically self-auditing your plan to make sure it is running properly and to head off problems before they become more expensive to fix. The IRS considers proactive self-audits and self-corrections essential to operating a retirement plan in compliance and recommends that plan sponsors conduct regular reviews of their plans.
In a self-audit, plan operations should be checked to make sure that 1) no errors have recently occurred based on the terms of the plan document and current regulations, and 2) there are processes and staff in place to manage each element of plan operations. Here are some examples of common mistakes and the steps plan sponsors may take to discover them.
  • Excluding eligible employees – Inspect payroll and plan records to ensure that eligible employees timely entered the plan; verify that employees are being notified when they become eligible to participate in the plan or are automatically enrolled if applicable
  • Incorrect contribution allocations – Review current and past years’ employer contributions to ensure they follow the formula designated in the plan document and have been allocated to eligible employees
  • Incorrect definition of compensation – Review the definitions of compensation in the plan document for allocations, deferrals, and testing to ensure they are being applied correctly in plan operations (e.g., base pay for profit sharing contributions, base pay plus bonus for deferrals)
  • Nondiscrimination testing failures – Make sure plan compliance testing (e.g., ADP/ACP) has been conducted according to the plan document elections and that employees were properly classified as highly or non-highly compensated employees
  • Inaccurate payroll and census data – Verify the accuracy of the payroll data, birth dates, hire dates, and termination dates provided to plan service providers
  • Failure to follow loan policy – Spot-check loan agreements to confirm that loans are being administered according to the terms of the plan’s loan policy
  • Missed amendments – Verify that the plan document was restated by July 31, 2022, and is up to date for other amendments required for law changes or changes in plan features
While recordkeepers and third-party administrators (TPAs) are typically engaged to help administer plans, the plan sponsor is responsible for making sure the plan complies with all applicable rules. The IRS has created two tools to help plan sponsors make sure their plan is compliant and correct any mistakes discovered.
  • 401(k) Plan Checklist – a series of questions to help plan sponsors audit plan operations
  • 401(k) Fix-It Guidean interactive guide to help plan sponsors determine whether a mistake has occurred and how to correct it
Correcting Plan Mistakes
The IRS wants to improve plan compliance by promoting voluntary corrections for plan sponsors who discover errors on their own. The IRS’s EPCRS can be used to correct many types of errors. Some correction methods require plan sponsors to make additional contributions to correct the error, but these will still cost less than corrections and sanctions made under an IRS audit. The EPCRS consists of three subcomponents:    
  • Self-Correction Program (SCP) – for insignificant errors, or significant errors corrected within three years, plan sponsors may correct operational problems without notifying the IRS or paying a fee
  • Voluntary Correction Program (VCP) – for qualification errors, plan sponsors can submit a correction application to the IRS and pay a user fee
  • Audit Closing Agreement Program (Audit CAP) – if the IRS discovers a failure during an IRS examination, the plan sponsor will be subject to a sanction based on the extent and severity of the failure
Here is an example of a common plan mistake and the general correction procedures.
An eligible employee wasn’t given the opportunity to make an elective deferral election [1]
  • Make a corrective qualified nonelective contribution (QNEC) of 50% of the missed deferral (see below for ways to reduce this contribution). The “missed deferral” amount is calculated by multiplying the employee’s compensation for the year by the actual deferral percentage for the employee’s group (highly or non-highly compensated employees).
  • Make a corrective contribution if an employer contribution was missed, based on 100% of the missed deferral, and adjust for investment earnings.
Plan sponsors may reduce or eliminate the QNEC under the following circumstances:
  • No QNEC is required if
    • Employee is currently employed at time of correction
    • Correct deferrals begin within 3 months of when employee was eligible to defer
    • Special employee notice is provided within 45 days of being given the opportunity to make deferrals
  • A 25% QNEC is required if
    • Employee is currently employed at time of correction
    • Correct deferrals begin later than 3 months but before the end of the third plan year after the error occurred, or if earlier, the month after the affected employee first notified the plan sponsor of the error
    • Special employee notice is provided within 45 days of being given the opportunity to make deferrals
The correction procedures and calculations can be complex. Plan sponsors should engage a plan corrections expert or legal counsel to determine the exact requirements applicable to the specific situation.

Conducting periodic plan check-ups can help plan sponsors ensure their plan is operating in compliance with the plan document and the current rules—as well as prepare for a pre-examination self-audit that will be required if the plan is selected for the IRS’s 90-day compliance program.
[1] 401(k) Plan Fix-It Guide – Eligible employees weren’t given the opportunity to make an elective deferral election (excluding eligible employees), August 12, 2022,
This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before making any decisions. Newport and its affiliates do not provide tax, legal or accounting advice.

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